How To Start Investing For Beginners And Why You Should Start Now
Investing your money is one of the smartest ways to create long-term wealth. However, investing for beginners can be confusing. So let’s look at the best investment types you should focus on and how to get started. Then, the whole process becomes easier.
Investing For Beginners
Before we discuss investing, let’s take a look at savings. It’s something the majority of people are familiar with.
You put money in a savings account or a fixed deposit, and the bank promises you interest every month. You may notice that the interest you’re getting is very small. Thus, the problem is your money stored in the bank is losing value to inflation and the interest earned is not enough to offset it.
Have you wondered what banks do with your money? Or what they had to do to give you the interest payments?
Banks loan it out to businesses and properties at 7% annual interest rate or higher. You can think of it like they’re investing the money for you. After collecting the loan repayments, they give you a small cut.
Now you may be thinking that’s not a good deal. That is why people turn to investments to get higher returns.
Investing is where you put money in an asset like stocks, real estate, or a business with an expectation to get income or profit. Essentially, think of investing like your money working hard to make you more money.
Why You Should Start As Early As Possible
The data doesn’t lie. People that started investing from a young age are more likely to grow their wealth at a later age.
One of the main reasons is due to compounding. The great Albert Einstein refers to compound interest as “the eighth wonder of the world.” Let’s have a look at an example of compounding.
You invest $10,000 and get a 5% yield annually. In the first year, the 5% gain is $500 so your balance becomes $10,500.
The next year, you’re still getting 5% gains. But this time it’s 5% of $10,500, which is $525 gains. Your total balance grows to $11,025. The following year, it’s $551.25 gains for a total of $11,576.25.
As you can see, the yield gets larger and larger. Given enough time, anyone can start with a modest amount and be wealthy with the magic of compound interest.
There’s a simple rule of thumb often used in the investing world. It’s called the Rule of 72. It’s a simple way to find out how long your investment will take to double assuming a fixed annual rate of interest.
Simply divide 72 by the annual rate of return. The result is how many years it will take for your initial investment to double. This is not exact but it gives you a good rough estimate.
For instance, at a 5% rate of return, 72/5 = 14.4. This means it will take 14.4 years for the $10,000 to become $20,000.
Importance Of Diversification
When you ask any good fund manager, they will tell you to diversify your portfolio. Or you may have heard “Don’t put all your eggs in one basket”.
When it comes to investing, diversification is a method to reduce your risk by putting your investments in different types, industries, categories, etc. Ideally, you want to invest in different areas that react differently to an event.
When adverse events happen in the economy, your whole investment is not going to all lose value at the same time. For instance, bonds and stocks typically move in opposite directions. A negative result in one would be offset by a positive result in the other market.
Even though diversification doesn’t guarantee you won’t lose money, it’s important to minimize your risk.
Now let’s discuss the different types of investment and how you can diversify.
Types Of Investments
Investing In Stocks For Beginners
Investing in stocks, sometimes referred to as equities, is popular among new investors.
There are two main ways you make money in stocks. The first way is capital appreciation. Let’s take Apple stock for example. On 11 Jan 2019, the stock price is $152.29 and you bought 100 shares for $15,229. A year later on 10 Jan 2020, the stock price has gone up to $310.33. If you sold all 100 shares, you would get $31,033. Your capital gain is $15,804 minus some transaction fees. Capital appreciation in stocks is when you buy low and sell at a higher price.
The second way to earn money from stocks is to receive dividends. Dividends differ from company to company. Some companies pay out some of the earnings to their investors, while some companies prefer to reinvest their earnings to grow their business.
Coca-cola is one example of an established company that pays out dividends every quarter. The most recent payout is $0.40 per share. So if you had 100 shares in Coca Cola, you would have received $40 in cash or you could choose to reinvest it for more shares.
One downside of investing in the stock market is it can be volatile. It has an up and down cycle. For example, 2 months later on 20 Mar 2020, the Apple share price went down to $229.24 per share
If you invest in a good company with good prospects, there’s a potential of high returns in the long run.
Target-Date Mutual Funds
Before we discuss target-date mutual funds, first let me explain what a mutual fund is.
Mutual fund is a basket of investments. A professional fund manager chooses how the fund is invested. Usually, there is a general theme. For example, there is a mutual fund that invests in US stocks. And there is a mutual fund that invests in short term government bonds.
When you buy a share in the fund, you invest in everything the fund is holding with a single transaction.
Target date mutual funds work similarly but with a date in the future. You give your estimated retirement year in mind, and your money is automatically invested.
Target date mutual funds typically hold a good mixture of bonds and stocks. The exact composition depends on how many years until your planned retirement. For example, if you choose a target-date fund with 2050 in the name, it means that you plan to retire in 2050. As that is 30 years away, the fund will mostly hold stocks, which tend to provide higher returns over the long term.
However, if you choose one that has a closer retirement date, or as the year 2050 comes nearer, your investment composition automatically shifts to contain more bonds. That’s because bonds tend to have a lower risk compared to stocks.
As you can see, target-date mutual funds are a perfect investment for beginners who do not want to be heavily involved.
Index funds are similar to mutual funds. Look at it like mutual funds on autopilot.
There’s no professional manager who is controlling the investment portfolio. Instead, the index funds mirror a market index.
A market index is a group of selected investments that represent a portion of the financial market. In the US, there’s the S&P 500 market index. It comprises of the stocks of 500 of the largest companies in the US. Then there is the S&P 500 index fund which tracks the S&P 500 market index.
Similar to the mutual funds, you’re buying a basket of investments. If you buy the S&P 500 index fund, you have invested in a collection of 500 large companies in the US in one transaction.
An advantage of the index funds compared to the mutual funds is the fees. Mutual funds have a professional portfolio manager whereas index funds are fully automatic with no human intervention. That’s why index funds have lower expenses, which can save you money in the long term.
Moreover, index funds share price fluctuates throughout the day like stocks price. You can choose exactly the price you want to buy at. On the other hand, you don’t know the exact price of a mutual fund when you buy it. You simply invest a sum of money and after all the investments in the portfolio are calculated, they will let you know how many shares you received and the price per share.
Exchange-traded Funds (ETFs)
ETFs work in a similar way to index funds. You can buy an ETF that tracks a market index like the S&P 500.
ETFs are traded like stocks. So brokers charge a commission whenever you buy or sell them.
However, there are some brokers that offer commission-free ETFs. All you need to do is set up automatic investments. Each week or month, you’re buying more shares in the ETF. So by setting aside some money on a regular basis, you save on extra charges and build a good habit of investing money for beginners at the same time.
Fixed Income Securities
Fixed income securities are different from the other types we’ve discussed so far. It works like debt where the borrower pays regular interest payments.
Fixed income securities are debt instruments issued by government, corporations and other entities. The money raised by selling these securities is used to finance their operations. These securities have a maturity date ranging from 30 days to 30 years.
When you buy fixed income securities, you get paid regular interest payments of the principal. The higher the risk of the borrower defaulting, the higher interest payments for you. And when it matures, you get your principal amount back.
Typically, these are low-risk investments so returns are on the low end. Let’s be honest. You’re unlikely to grow your wealth with just securities. But it’s still a great place to earn some interest for your money.
Next Steps: Where Can I Start?
Now that you know the investment types, it’s time to get started with investing. You’re about to discover 4 simple ways to start investing for beginners.
Investing Through Your Company’s 401(k) Plan
A good place to start is checking with your company. Find out if you have a 401(k) or another retirement plan at work. If there is, then it’s a great place for you to start.
Some companies even match a portion of your contribution. That means free money for you to invest. The return on your investment on free money is infinite since it’s all profits to you.
When you choose to contribute to your 401(k), the money will be deducted directly from your paycheck. And most contributions are pretax.
There isn’t a minimum to start investing in 401(k). But there is a maximum contribution. In 2020, the maximum is $19,500 if you’re below 50 years old and $26,000 if you’re older than 50. You don’t have to invest the maximum. You can choose any sum that you feel comfortable with.
However, you may want to take advantage of the matching contribution from your employer. One common matching arrangement is 50% of the first 6% of your salary you contribute. This may sound confusing so let’s see an example.
Let’s say you earn $50,000 per year. To maximize the employer matching, you need to contribute 6% which is $3,000. And your employer will give 50% of that which is $1,500 of free money to you.
This may be out of reach for some people, especially if you’re on a tight budget. He most important thing is to develop a habit of investing. For example, you can start with 1% of your paycheck. It’s a small amount which you won’t even notice. Then gradually increase it every year. In year 2, you can increase it to 2 percent of your salary. And 3% of your pay in year 3, and so on.
It’s even better if you time the contribution increase with your annual pay rise. That way you will barely notice any increase. And your money keeps growing over time.
You have several choices on how you invest in your 401(k). Some will put your funds in a target-date mutual fund by default. Contact your HR department to sign up for your 401(k) and find out your investment options.
If you know you’re supposed to invest and have already saved the money to do it, but you don’t want to do it yourself, then you will love robo-advisor.
Robo advisor is a service that uses computer algorithms to manage your investments for you.
Since there’s no investment managers and overhead is low, you are only charged a low fee. Typically they charge 0.25% to 0.50% of your account balance every year. Many of them will also let you open an account with no minimum sum.
Thus, robo-advisors are great for investing money for beginners. You can get started investing with little money. You don’t need any investment experience. And it’s easy to get set up. Then robo-advisors use their intelligence to do most of the work for you.
This is great when you’re learning how to invest. You can see how robo-advisors put together a portfolio and what investments are selected.
Although robo-advisor manages your investment, as with any type of investment, you still need to monitor it. It’s your money after all.
Sign up with one of our top picks of robo-advisor platforms and get started.
- M1 Finance
Investment apps are popular when it comes to investing in stocks for beginners. It’s appealing because you get a variety of services at low fees.
In the past, you would have to pick up your phone and call a stockbroker to buy or sell stocks. And the stockbroker would charge a steep commission to execute the trade.
Now with investment apps, you pick up your phone, open the app and with a few taps on your screen, you have made a trade instantly for free or at a very low cost.
Even experienced investors could also save money and improve their portfolios by using an investment app.
There are many investment apps out there, each one with different appeals. Let’s take a look at some of the top investment apps:
- Acorns – Best for automated investing
- Stash – Best for learning about investing
- Clink – Best for Micro investing
- Vault – Best for retirement investing
- Wealthfront – Best for college savings
Online Brokerage Account
If you’re going to invest in stocks, you need an online broker. There are many online brokers to choose from. Here are some things to consider when choosing the right one for your needs:
- Reasonable minimum investment. Some have lower minimum investment but charge higher fees. And some with higher minimum investment charge lower fees. Choose one with a minimum investment amount you’re comfortable with.
- Quality Trading Tools. These tools make placing your orders easier. Make sure you select one that fits your needs.
- Access to Customer Service. If something were to go wrong, the last thing you want is unresponsive customer service. Find an online broker that gives you fast and reliable assistance when you need it.
- No hidden fees. Surprises are no fun. Look at all the fees chart and compare them before deciding on a brokerage account.
Here are some of the recommended brokers. Sign up with them and get started on your investing journey.
- TD Ameritrade – Best broker for beginners
- Charles Schwab – Best broker for ETFs
- Interactive Brokers – Best broker for advanced traders and for international trading